Pakistan Cements: Maintain positive outlook despite the surge in coal prices

  • Rising coal prices will trim IMS cement universe earnings by c.9%/7% in FY22/FY23 as compared to our previous estimates
  • Higher local demand and retention prices will ease the negative impact of international coal prices to some extent
  • Elevated PSDP to PKR900bn and extension in construction amnesty in upcoming budget will increase the demand for cement

We are revising the estimates of our Cement Universe, to adjust for rising global coal prices (up 33% since Feb 2021). Our EPS estimates for FY22/23f are down by 9%/7% on average. Note that we also assume higher local demand, which should allow better pass-through and higher retention prices – containing the decline in margins due to higher coal prices.

We have also rolled over our target prices to June 2022, hence our TPs are largely similar to before the above changes. The cement stocks in our coverage are still offering more than 20% potential upside (except for CHCC). Hence we remain Overweight on the sector.

Our top picks are (i) FCCL for the ability to exceed sales beyond its capacity share, (ii) KOHC for high sensitivity to cement prices and relatively less leverage, (iii) LUCK for superior diversification, and (iv) DGKC for more varied drivers of earnings growth.

Surge in coal prices trims estimates; remain Overweight

In light of the recent increase in global coal prices, we have revised the coal and cement price assumptions in our estimates. We had assumed average coal prices of c.US$70/ton for FY22 onwards; coal prices surge seasonally every winter, but prices have proved sticky this time (as in case of other commodities). Therefore, we now assume coal prices at US$100/ton for FY22 and US$90/ton thereafter. But, we also foresee higher local sales growth (10%/8% yoy in FY22/23f) on top of the c.20% yoy growth in FY21td, which will allow for partial pass-on of costs and higher retention – thereby checking our estimate cuts. We have also rolled over our target prices to June 2022 (TPs are largely unchanged, as a result). Our TPs still imply more than 20% potential upside (except in case of CHCC). We thus remain Overweight on the sector; our top picks are FCCL, KOHC, LUCK and DGKC. 

FY22 Budget is around the corner; positives abound

The federal government will announce the FY22 budget on 11 June 2021. Reportedly the government will allocate PKR900bn to PSDP, as compared with the PKR650 allocation for the outgoing FY21. This strengthens our conviction on local demand growth. Note that the c.20% yoy growth in local cement dispatches in FY21td was primarily led by private sector demand following the government’s Construction package (in place since the outset of Covid-19 pandemic). Thus, an increase in public infrastructure projects will sustain the present momentum in local demand, in our view. Also, some news reports suggest that the government may abolish the 5% custom duty on imported coal (potentially as a way to contain future price increases; similar to the FED reduction in 2020). Refer the sensitivity to this change given inside. If this happens, then our EPS estimates will increase by 5-6% on average. On the other hand, it is unlikely that the government will reduce FED and GST on cement, in our view.

New expansions are not yet a threat

The overall cement industry utilization is likely to stand at c.82% by end FY21, and it can cross c.95% by FY23, in our view. Most planned brownfield expansions are also expected to come online in FY23, followed by the green-field ones, which will take at least a year more to come online. Therefore, the risk of the return of price competition (similar to that during FY18-19) is unlikely, in our view, mainly due to robust demand growth and healthy utilization levels.

Additionally, the upcoming expansion cycle will be different from the previous one, as this time most cement producers have availed concessionary loans under the LTFF and TERF programs, which are expected to cover c.50% of total expansion cost with repayments to last 10 years (including two years’ grace period). These facilities will significantly reduce the financial burden, in case the industry enters another period of slow demand growth post-expansion, in our view.

We remain Overweight on the sector

While we have Buy ratings on all the companies in our coverage, we prefer companies that are either selling more than their capacity share or have a presence in both regions (such as FCCL, LUCK and DGKC). Our top picks are:

  • FCCL (TP PKR38/sh) for higher retention prices, cost efficiencies (lower fixed cost per ton) and for selling more than its prescribed market share;

  • KOHC (TP PKR315/sh) for its high sensitivity to cement prices (alongside CHCC and PIOC), lower fixed cost per ton, and relatively less leverage;

  • LUCK  (TP PKR1,300/sh) for superior profitability, because of not only cement operations, but also Lucky Motor and the imminent commissioning of its coal-based power plant (LEPCL); and

  • DGKC (TP PKR185/sh) for the higher earnings growth due to greater export-to-local sales substitution and energy cost savings by shifting on alternate sources.

Coal prices are not likely to correct much in 2021

Since February 2021, global coal prices have rallied c.33% to a new recent high of US$113/ton. The trend began when with the early economic rebound in China from the Covid-19 pandemic and later in the West. Meanwhile, several coal exporters, including Brazil, were hit by production and other supply issues. This emerging shortage was exacerbated by China refusing to buy coal from Australia (the second-largest coal producer). Recently, price catalysts include heavy rainfall in Indonesia. Therefore, we now see a high likelihood of global coal prices sustaining the US$90-100/ton levels until the end of 2021.

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